Microsoft is currently facing a cool reception from Wall Street. In recent months, the company's stock performance has lagged behind the S&P 500 index, with shares falling sharply following its earnings report last Wednesday. Based on the price-to-earnings ratio relative to operating profit, its stock price has dropped to its lowest level since 2022. This investor reaction stems from a slight slowdown in the growth of Microsoft's closely-watched Azure cloud computing business, while overlooking a more critical big picture.
Microsoft's Chief Financial Officer, Amy Hood, informed analysts last week that Azure's growth rate for the quarter could have been faster if more computing resources had been allocated to it. Instead, Microsoft directed a significant portion of its computing capacity towards its enterprise software business. This decision is actually quite logical: the software division is Microsoft's largest and most profitable segment, maintaining a stable gross margin of around 81%. In contrast, the Intelligent Cloud unit, centered on Azure, has a gross margin approximately 20 percentage points lower than the software business and is continuing to decline. This indicates that Azure's expansion is exerting downward pressure on Microsoft's overall gross margin.
However, growth in the software business is able to offset this pressure, and Microsoft is skillfully executing this balancing act. Since the introduction of various new AI services, Microsoft's overall gross margin has remained stable at around 68% over the past few years. Concurrently, Microsoft has demonstrated significant effectiveness in cost control. As noted by Jackson Ader, a software industry analyst at KeyBanc Capital Markets, since the launch of the Copilot AI software tool suite in early 2023, Microsoft's operating margin has increased from approximately 41% to over 47%.
Microsoft's aggressive promotion of AI-driven software products like Office 365 Copilot is yielding initial results. Company executives disclosed last week that paid Copilot users reached 15 million in the last quarter, a surge of 160% year-over-year. While this number remains modest in the broader context—Microsoft's Office products had 400 million paid users as of 2024—Copilot's subscription count is already double that of Google's Gemini Enterprise service. A recent survey of software resellers conducted by Ader revealed that 31% of their clients are showing significant interest in GitHub Copilot, the AI assistant integrated into Microsoft's developer software.
Notably, revenue growth in Microsoft's Productivity and Business Processes segment, which includes Copilot, accelerated to about 16% in the first half of the current fiscal year, up from 13% for the full 2025 fiscal year.
Despite this, data from the financial platform Koyfin shows that as of last Friday, Microsoft's forward price-to-earnings ratio based on expected EBITDA for the next year was only 15.2 times. This is below its average of 20.5 times since early 2021. Even compared to ServiceNow, a much smaller enterprise software company with similar growth rates, Microsoft trades at a valuation discount, despite ServiceNow having a far lower operating margin in the teens, compared to Microsoft's sustained level above 40%.
Mark Malik, Chief Investment Officer at wealth management firm Siebert Financial and a Microsoft investor, stated that bullish investors see the current period as an opportune time to invest in Microsoft. He characterized the recent stock decline as an overreaction by the market, adding, "Considering Microsoft's 28% earnings-per-share growth, a rational product portfolio, and deep business foundations, I believe the company's operational management is excellent."
Pessimistic views on Microsoft primarily stem from uncertainties surrounding the future of its software business, which contributes over half of its profits. Both established software firms and startups are launching a variety of new AI tools, which could potentially disrupt existing enterprise software products in the market.
Microsoft has not developed 365 Copilot as a standalone product but has integrated it into the existing Office 365 suite. This means customers must pay an additional fee to access the feature. For businesses unwilling to subscribe to this premium service, a pay-as-you-go option via Copilot chat services is available, though this method could potentially be more expensive. The challenge for Microsoft is to ensure that corporate clients do not simply replace existing software with other AI products, thereby maintaining their spending levels on Microsoft's software.
Another major question is whether Microsoft can keep pace with younger competitors. Tomasz Tunguz, a venture capitalist at Theory Ventures, commented on a tech investment television program this past Thursday that while Copilot had a first-mover advantage, it is now beginning to show signs of becoming outdated. Citing innovations like Anthropic's Claude Cowork and the rise of the code-assistance tool Cursor, he said, "Microsoft's innovation intensity has waned, and its momentum is far less than other players in the industry." He believes there is valid reason for concern that fewer companies may choose to upgrade to Copilot in the future.
Nonetheless, Microsoft benefits from a deep-seated first-mover advantage in the industry. Corporate clients are unlikely to switch providers rapidly, buying Microsoft time to catch up with competitors. Copilot offers customers a choice of multiple AI models, allowing them to leverage innovations through software deeply integrated with Microsoft's existing products—a significant factor that gives customers pause before considering alternative services.
For investors skeptical about the prospects of Microsoft's software business, the cloud division provides another rationale for investing in the company. Siebert Financial's Malik indicated that his optimistic outlook for Microsoft stems more from the long-term infrastructure build-out behind Azure—where demand currently outpaces supply—than from confidence in its software business.
Regarding the Azure cloud business, Microsoft faces a risk common to all leading cloud computing firms: the requirement for massive capital expenditure to build AI data centers equipped with vast numbers of graphic processing units, with the profitability of these investments still uncertain.
However, in Malik's view, Microsoft is in a better position than most of its peers. He stated, "We all know cloud computing is highly capital-intensive. Microsoft's revenue scale is sufficient to support such investments, and its cash reserves on the balance sheet provide a safety net. In contrast, companies like CoreWeave, which are also building AI infrastructure, lack Microsoft's revenue scale and the support of mature, large-scale business operations." CoreWeave is an emerging cloud computing company attempting to compete with major cloud providers in the AI arena.
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